How Much Would a Small Interest Rate Hike Affect Your Total Mortgage Costs?

The world is watching and waiting to see whether the U.S. Federal Reserve will raise interest rates this month, or at least by the end of 2015.

A rise in the “federal funds rate” will translate pretty quickly into higher mortgage interest rates, affecting any prospective homebuyer who can’t simply pony up a few hundred thousand dollars in cash. (The fed isn’t the only driver of mortgage interest rates, but it’s a factor in the mix.)

Given that nearly a decade has passed since the fed raised this rate, most experts don’t believe it will do anything more than inch it up. This isn’t a time for shock strategies.

The prospect of a rise in the rate nevertheless raises a question for prospective homebuyers. How much would a small rise in mortgage interest rates affect the amount you ultimately pay for your mortgage (assuming you choose a fixed-rate loan)?

Let’s assume you’re buying a $500,000 home, putting 20% down ($100,000, ouch) and will therefore be taking out a $400,000 mortgage. The reported 30-year rate on Bankrate.com today is 3.96%.

According to Nolo’s calculator, your monthly payment on this loan would be $1,900, and the total interest you’d pay over the life of the loan would be $284,161.

Now let’s assume interest rates go up a notch, to 4%. That would take your monthly payments to $1,910 and your total interest paid by the end of the loan term to $287,478 — $3,317 more than you would have owed in our first example. Not awful, over 30 years.

Let’s keep going, and take those interest rates up to 4.5%. (Could happen!) That would boost your monthly payments to $2,027 and your total interest paid by the end of the loan term to $329,627. Things are starting to look more serious.

What about 5% mortgage rates? They’re still within the realm of where experts predict rates might go in the coming months or year. A mortgage at 5% on your $400,000 loan would come with monthly payments of $2,147 and bring your total interest paid to $373,021.

Them’s real dollars. With a seemingly small rise interest rate on the day you close on your home, from just below 4% to 5%, you’d be looking at owing $88,860 more in total interest by the time you’d paid that loan off.

Of course, if housing prices were to go down as a result of the rate hike, that would offset part of the problem – but no one seems to think they will.

Now might be a good time to get serious about buying a home. A trusted mortgage broker can also help you think strategically about how to finance your purchase.